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Political Decentralization and Fiscal Management of Local Governments: Evidence and Lessons from Korea No-Wook Park Center for Fiscal Analysis Korea Institute of Public Finance

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Purpose of the Presentation Share Korean experiences by examining the effects of political decentralization (resumption of local elections) on the fiscal management of local governments –Resumption of Korean local elections in 1995 –Identify differences in fiscal managements before and after the resumption of local elections –Derive lessons and implications from Korean experiences

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Decentralization Process Decentralization is a globally popular since 1990s –Many developing countries have experimented with decentralization reforms –Decentralization reforms are in full swing with the initiatives of the current administration in Korea

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What is Decentralization? Devolution of various authorities (powers) to the lower level of governments –Fiscal decentralization More fiscal decision making authority and economic resources in local governments –Political decentralization Local governments are formed by local residents –Administrative decentralization More administrative decision making authority in local governments

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Why Decentralization? Expected benefits of decentralization –Increase in efficiency Local governments have better local information Competition among local governments improves the performance of local governments Expected benefits of centralization –Realization of economies of scale –Internalize externalities across local governments Recent trend reflects the perception that movement towards decentralization may bring in benefits.

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How to Decentralize? Proper assignment of various authorities between central and local governments Capacity consideration is important. –Capacity for decentralization needs to be developed. –Local governments tend to lack capacity to cope with various issues. Administrative capacity Restraining corruption

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Political Decentralization How to select local officials –Election: Politicians –Appointment: Bureaucrats Resumption of local elections –Appointment  Election

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Why Do Local Elections Matter? Different Incentives –Politicians Winning Elections –Bureaucrats Career Concerns Local Elections as an Issue-Unbundling Mechanism –Elected Local Officials Mainly Care for Local Issues –Appointed Local Officials Care for both of Central and Local Issues

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The Korean Case Resumption of Local Elections in 1995 –Opportunity to examine the effects of political decentralization –No significant devolution of economic resources to local governments –Appointed officials  Elected Officials

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Research Questions Do elected officials manage differently in their fiscal issues? In addition to elections as a way of selecting local officials, do other political factors matter? –Political competition in each district –Alignment with the incumbent president

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Summary of Results 1 More fiscal independence –Exert efforts in increasing internal revenues Raising revenues through non-tax revenues as opposed to through local taxes –Minimize political costs associated with raising internal revenues

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Summary of Results 2 Do not face harder budget constraints –Rely more on intergovernmental transfers than local borrowings Political competitive districts receive more intergovernmental grants –Political decentralization may activate distributive politics

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Institutional Backgrounds Political decentralization Regional identity based voting and imperial president

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Political decentralization 1 Resumption of local elections for the head of local governments in 1995 –Suspended since 1961 –3 year term and term-limit is 3 times –Higher level local governments 7 Metro-cities and 6 provinces –Lower level local governments 232 cities, counties and districts in 2000

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Political decentralization 2 No significant fiscal decentralization during 1991-1999 Local tax revenue –20 percent of total tax revenue Local government’s budget share –35-43 percent of total government revenue

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Voting Behavior and Imperial Presidency Regional identity-based voting Imperial presidency Importance of Swing Voters (Districts) –Expected to be important given strong regionalism Importance of Alignment with president –May not be important

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Data 1 Local government fiscal year book during 1991-1999 –No significant change in fiscal rules related to local governments Cities, counties, and district level data –232 cities, counties, and districts in 2000 –Due to administrative boundary changes in 1995, 123 local governments are analyzed.

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Summary 2 Political characteristics of districts matter for attracting subsidy from the central government after political decentralization. Internal revenue raising efforts through non- tax revenues are significant regardless of political characteristics.

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Other Implications Political institutions are important in realizing benefits of decentralization. Political environments shaping incentives of local officials are crucial. –Can local residents (voters) discipline local officials? –Availability of Information on the fiscal management of local governments –How to avoid a possibility of collusion between local officials and powerful local interest groups